Fairfield County braces for tax deduction caps

Neil Vigdor

Published 9:58 pm, Saturday, January 19, 2013

Somewhat lost in the fine print of the 11th-hour compromise that kept the nation from barreling over the fiscal cliff is the reinstatement of a pair of provisions capping itemized tax deductions and personal exemptions for the wealthy, which tax watchdogs say will disproportionately hit Connecticut's Gold Coast.

Put on ice by President George. W. Bush as part of his much-debated tax cuts of 2001 and 2003, the provisions will affect single filers earning over $250,000 and couples with joint incomes in excess of $300,000.

They are known as the Personal Exemption Phaseout and Pease provisions, the latter of which was named for Donald Pease, the late Ohio congressman and Democrat.

Both provisions have been significantly overshadowed by increases to the top marginal tax rate for single filers earning over $400,000 and couples above the $450,000 threshold.

"The way these things operate, it's kind of hidden," said Nick Kasprak, an analyst with the Tax Foundation in Washington, D.C. "Certainly, it can be a significant hit for some people. Teasing out the ultimate effect of these things can be difficult unless you're a tax expert."

Many filers are able to reduce their exposure to federal income taxes through itemized deductions for expenses such as state income and local real estate taxes, mortgage interest and charitable contributions.

But for every dollar an individual is over the $250,000 income threshold -- $300,000 for couples and families -- 3 percent will come out of their itemized deductions under the Pease provision.

So if that couple's income is $400,000, they would owe an additional $1,000 in taxes under the 33 percent bracket. If it is $5 million, they would owe an additional $55,836 under the top 39.6 rate.

All but one of Connecticut's five members of the U.S. House voted for the American Taxpayer Relief Act of 2012, the formal name for the fiscal cliff legislation approved by Congress on Jan. 1.

U.S. Rep. Jim Himes, D-Conn., who represents most of Fairfield County and backed the measure, said it's important to examine the provisions in the broader context of tax reform.

"This points us in a helpful direction, though, which is, I've been saying for a long time, that tax reform, it's not just me, most economists will tell you that tax reform should involve reducing deductions and credits, simplifying the code," Himes said. "So I've always had a bias towards raising revenue by reducing deductions and credits as opposed to raising rates."

The PEP provision eats away at the personal exemptions claimed on income tax filings, which are set at $3,900 per family member in 2013.

For every $2,500 a individual is over the $250,000 threshold -- $300,000 for couples and families -- they will lose 2 percent of that exemption.

A family of two adults and four children with an annual household income above $300,000 would pay at least $154 in additional taxes for every $2,500 that they are over the threshold.

So if that family's income is $500,000, it would owe $9,266 additional under the top 39.6 percent rate.

Between the two provisions, they are expected to raise $150 billion in revenue over the next 10 years, according to Curtis Dubay, a senior tax policy analyst with the Heritage Foundation, a conservative think tank.

Dubay expects wealth centers like Fairfield County to take it on the chin, and blamed Democrats.

"This is exactly who it was designed to hit," Dubay said. "There's no hiding that fact.

"It raises an awful lot of money from rich people, which has been their objective for a long time."

Dubay characterized the PEP provision as anti-family.

"The people who get hit the hardest are going to be families with a lot of kids," he said.

Conservatives aren't the only one to take note of the deduction caps.

"Obviously, you've got higher deductions in Fairfield County," said Democrat Ned Lamont, the wealthy Greenwich cable television entrepreneur who ran for governor in 2010 and the U.S. Senate in 2006.

"I guess it is true that, as opposed to say raising the top marginal rates, this will reduce the exemptions of people with a lot of exemptions and kids," Himes said. "So yes, I think that's accurate that this will disproportionately hit families with a lot of kids. It's important to remember that you're also talking about quite affluent families."

Still, Himes said the impact will be softened to a degree by changes lawmakers made to the alternative minimum tax. Those changes including permanently adjusting income exemption levels to inflation and carving out larger exemptions for lower-income taxpayers so they avoid the AMT altogether.

"If you're talking about not the very wealthy, but if you're talking about the mass affluent, if you will, there will be some offset of the financial impact of what you're talking about by fixing the AMT," Himes said.

U.S. Sen. Richard Blumenthal, D-Conn., acknowledged that the deal had its flaws, but said in a statement to Hearst Connecticut Newspapers that it was better than going over the fiscal cliff.

"Although I believe we could have reached a better solution sooner, I voted in favor of this agreement because it was better than no deal at all," Blumenthal said. "The deal that passed protects every American from facing higher tax rates on the first $400,000 of their income and extends unemployment benefits to protect 43,000 Connecticut residents from immediately losing their unemployment benefits. It was by no means perfect, but it was far better than the alternative."

Fellow Democrat Christopher Murphy, a U.S. Senate freshman who was a member of the House when the vote took place, defended the increases in a statement issued by his spokesman Ben Marter.

"Like the vast majority of families in Connecticut and across the country, Sen. Murphy believes that the most fortunate among us should contribute a little more to deficit reduction, schools, roads, bridges, and other priorities that help make our country strong," Marter said.